Accounting Principles Flashcards

1
Q

What are the key financial statements that companies provide?

A
  1. Profit and loss accounts.
  2. Balance sheets.
  3. Cash flow statements.
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2
Q

What is the difference between management accounts and financial accounts?

A

Management accounts are for the internal use of the management team

Financial accounts are the company accounts that are required by UK law (Company’s Act 2006).

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3
Q

What is the difference between a profit and loss account & a balance sheet?

A

A profit and loss sheet shows the companies income and expenditure and the resulting profit or loss.

A balance sheet shows what a company owns (its assets) and what it owes (its liabilities) at any given point.

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4
Q

What is a cash flow statement?

A

It is the actual or anticipated ingoing and outgoing of a company over the accounting period.

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5
Q

Explain your understanding of capital allowances, insolvency and sinking funds?

A

Capital Allowances - Tax relief for certain items purchased for the business, for example tools and equipment.

Sinking Funds - Sums that are set aside for future expenses or long term debt.

Insolvency - An inability to pay debts, where debts exceed assets.

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6
Q

What are liquidity ratios?

A

Liquidity ratios = current assets / current liabilities

Liquidity ratios measure the ability of a company to pay off its current liabilities by converting its assets into cash.

The ratio is usually 1.5 although this depends on the sector the company is operating in. For example, house builders often operate with a liquidity ration of 3 because they hold high value assets in unsold houses.

A ratio of less than 0.75 can be an early indicator of insolvency.

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7
Q

What are profitability ratios?

A

Profitability ratios measure the performance of a company in generating profits.

Trading profit ratio margin = turnover (cost of sales/ turnover).

Low margins may be due to a growth strategy from the company and do not result from bad management.

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8
Q

What are financial gearing ratios?

A

These measure the financial structure of the company and are indicators for external supplier of debt as well as for internal management.

They help to measure solvency.

Highly ‘geared’ company’s relay on borrowing & the payment of interest reduces profit.

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9
Q

What is the purpose of a Profit and Loss account?

A

To monitor and measure profit and loss

To compare against past performance and against company budgets.

For valuation purposes and to compare against competitors.

To assist in forecasting future performance

To calculate taxation.

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10
Q

What is the difference between debtors and creditors?

A

Creditors are business entities that are owed money by another entity that they have extended credit to. For example, if you have provided services to a client and they owe payment of your fees, you become a creditor to the client.

Debtors are business entities that owe money to another respective company. For example, if you have used a sub-consultant and still owe them payment of their fees then you become debtors of a sub-consultant.

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11
Q

What are management accounts?

A

These are accounts used for internal management use.

Accounts prepared for a lender, such as a bank, to evaluate how you’ll be able to repay the funding.

These accounts are not to be audited externally.

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12
Q

What is a financial statement?

A

These are forecasts of income and expenditure that can be used as an analytical tool to identify shortfalls and surpluses.

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13
Q

What is a profit & loss account?

A

They demonstrate a companies sales, running costs and resulting profit or loss over a period of time (usually 1 year).

They are used to compare sales vs expense.

They can also be used to identify works that are not profitable.

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14
Q

What is a balance sheet?

A

It shows what the company owns in terms of assets and liabilities.

The balance sheet can demonstrate the value of the business at any given time.

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15
Q

What is a cash flow forecast?

A

A cash flow forecast summarises the cash, or cash equivalents both entering and leaving a company or project entity.

On construction projects this is usually shown as an ‘S’ curve.

In terms of a project entity, there is usually a small financial outlay at the start, a steep increase outlay towards the midpoint and a taper towards the end.

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16
Q

What is an ‘S’ curve?

A

S-curve means standard and also refers to the shape of the expenditure profiles when shown in graphical form over the course of a construction project.

During the start of a project the expenditure is typically low due to site set-up and other enabling works.

As the works progress toward the middle of the programme the rate of expenditure will typically increase as more expensive materials such as M&E systems and structural components are purchased and installed.

Toward the end of the programme expenditure will slow down, shown by the flattening of the S-Curve.

17
Q

What are Escrow Accounts?

A

A separate account owned by a third party on behalf of two other parties.

It serves as a bank account with defined contractual conditions for the release of funds.

They can be used as a project bank account.

Mechanisms must be in place for the release of funds, such as payment certificates.

18
Q

When have you used accounts in your work?

A

To access the financial strength of contractors at pre-qualification stage or contract stage.

19
Q

How do you analyse a company’s accounts?

A

The client’s accounts will carryout a detailed analysis but I can look at the warning signs by calculating ratios including liquidity rations, profitability ratios and gearing ratios.

I should always calculate the ratios myself as those included within the company’s accounts may have been manipulated.

20
Q

How you carryout a credit check?

A

I use the ‘CreditSafe’ website, which my company subscribes to, providing access to company’s accounts.

I considered both the ‘group’s’ account and the relevant company’s account.

If the company’s credit rating is low, I calculate some ratios and pass on the information to my client’s accounts for them to further analyse.

21
Q

What are signs of insolvency in company accounts or credit checks?

A
  1. Low credit score
  2. Liquidity ration below 0.75
  3. A falling working capital ratio - suggesting they may have taken on more work than can be financed.
22
Q

Why would you not recommend the appointment of a contractor with a low credit rating?

A

There may be an increased risk of the contractor carrying out works which were not satisfactory.

It could present a risk of the contractor failing to deploy sufficient resources and materials to the project.

23
Q

What measures would you recommend if your client wanted to appoint a contractor with a low credit rating?

A

I would explore the option of requesting a performance bond that my client could call on if the main contractor failed to perform.

I would review interim payment applications to ensure that these are accurate and not over-claimed.

A project bank account may also provide an additional level of assurance and should be considered.